Under Construction - March 2013: The Ever-Shrinking Federal Budget: Preparing for Contract Cut-Backs

by Snell & Wilmer

On March 1, 2013, President Obama signed the order directing “sequestration” to go into effect. As has been repeated constantly leading up to sequestration, $85 billion will now be cut from the federal government’s budget through October 1, 2013, when the fiscal year ends. Then, a new “sequestration” will take effect. Unless the federal government takes action to direct specific cuts to various programs, such sequestration will continue to occur until $1.2 trillion is eliminated from the federal budget over the next 10 years. This sequestration-phased scenario is separate from the possible federal government “shutdown” that is scheduled for March 27, 2013, if further funding is not approved. Based on these uncertainties, many companies will choose different options to ensure survival.

Companies may choose to stop bidding on government contracts or may attempt to plan for the gradual elimination (or termination) of existing government contracts. As previously referenced in Under Construction, the government contractor that is prepared for the possible “stop work” order will be well-positioned to negotiate an orderly exit from government contracting. As many governmental agencies (at all levels) have not fully explained to its prime contractors the consequences of the existing sequester and the future budget cuts, prime contractors need to have candid conversations with government contracting officers about existing contracts and future solicitations. Subcontractors need to have the same candid conversations with the prime contractors about the same issues. This is especially the case with solicitations. If a proposed solicitation (or project) will be terminated, the offerors should not be wasting resources in preparing proposals or considering protests. Unless there are frank conversations among all parties, the ability to manage the budget cuts may be hindered and/or difficult.

If a government contract is terminated, a company should properly respond and ensure that it is complying with the various contractual terms and government regulations in winding down the contract. These terms and regulations, especially regarding the accounting requirements, are onerous. Moreover, companies should ensure that they are maximizing any equitable adjustments or other compensation through properly filed claims, while being considerate of not violating the False Claims Act (FCA). As companies are likely going to terminate employees, “whistle-blowers” who want to take advantage of the FCA may become the norm. Companies should take any “threat” of a possible FCA violation seriously and initiate an internal investigation. If appropriate and even if the claim does not have merit, the company may want to consider a possible voluntary self-disclosure to the government before a whistle-blower has an opportunity to report to ensure mitigation of any risk.

Companies may take the opportunity surrounding the uncertainty to acquire competitors or lower-tiered subcontractors. Many large government prime contractors have significant cash reserves as a result of the uncertainties from the Great Recession and the existing economic outlook. However, due to the significant number of government regulations related to government contracting, due diligence on any acquisition or merger should be intense. Both sides of any deal, regardless of how friendly the transaction is, should fully understand the due diligence requirements and ensure that the pricing of any deal is correct and that the necessary representations and certifications are made.

Companies may also look to new non-governmental commercial markets or foreign governments to maintain their commercial standing and competitive advantage. However, many foreign governments' contracting regulations are just as, or even more, onerous than the United States' procurement laws. For example, many foreign governments require that the United States company “offset” any sale to the foreign government by making significant purchases in the foreign country’s domestic market. These offsets sometimes lead to a confusing matrix of deals between multiple companies to ensure compliance.

In addition to complying with the foreign governments' contract regulations, the United States' government contractor must still abide by the United States’ laws including, at times, confusing international trade laws, such as the Foreign Corrupt Practices Act, the Export Administration Regulations and the International Traffic in Arms Regulations, to name a few. This is currently a significant area of enforcement by United States governmental agencies. Companies should ensure that its policies and procedures, international agreements and training are compliant to meet these requirements.

Regardless of what options are chosen by each company, these are uncertain times for government contractors. Many companies are relatively new to government contracting because they took advantage of the Recovery Act to weather the Great Recession and may not have truly appreciated the abundance of contractual terms and regulations that must be complied with when a contract is terminated for convenience. Companies should consider seeking knowledgeable legal and professional assistance to assist in navigating the unknown budgetary cut waters.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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